Farm Liquidation Carries Several Tax Implications

For a farmer facing liquidation or some type of debt restructure, there may be a number of unintended income tax consequences, says C. Robert Holcomb, an agricultural business management educator with the University of Minnesota Extension

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For a farmer facing liquidation or some type of debt restructure, there may be a number of unintended income tax consequences, says C. Robert Holcomb, an agricultural business management educator with the University of Minnesota Extension.

With debt reductions and liquidations on the rise, Holcomb takes a look at tax implications for those farmers in Minnesota in those situations.

Farm liquidation without multi-year planning can be very costly, he points out. In a forced liquidation, deferred income and pre-paid expenses can contribute to significant tax liability.

Grain and feeder livestock sales are the most expensive. Land and raising breeding stock are taxed as capital gains, while machinery and purchased breeding stock are taxed mostly as depreciation recapture. Depreciation recapture is the tax generated from the sale of a farm asset that has been depreciated, Holcomb explains.

Full or partial cancellation of a debt is generally considered income for tax purposes. Noteworthy, a bankruptcy case does not eliminate income tax liability.

Generally, there are two instances when cancellation of farm debt is not viewed as income for tax purposes. The first is when a farmer who is solvent (assets exceed liabilities) can exclude cancellation of qualified farm debt from income. In this case, the farmer is treated as insolvent (liabilities exceed assets) and cancellation of farm debt is not included in taxable income. Qualified farm indebtedness is debt from an unrelated lender who regularly lends money and in direct connection with farming if at least 50% of the taxpayer’s average annual gross receipts for the last three years is from farming.

The second instance when a farmer may exclude from income a canceled farm debt is if the farmer is insolvent (liabilities exceed assets). This provision only works to the extent of the insolvency.

For more details on this topic, including calculations using farm liquidation examples and tax code references, view “Farm Liquidation, Debt Forgiveness and Bankruptcy” at www.extension.umn.edu/go/1022.